TEXAS SUPREME COURT DISTINGUISHES EXXON’S EMPLOYEE INCENTIVE COMPENSATION AGREEMENT FROM NON-COMPETE AGREEMENT AND ENFORCES NEW YORK CHOICE-OF-LAW PROVISION

Exxon Mobil Corp. v. Drennen
Supreme Court of Texas, No. 12-0621 (August 29, 2014)
Justice Green (Opinion)
In a unanimous opinion, the Texas Supreme Court distinguished a forfeiture provision in a company’s incentive compensation plan from a covenant not to compete, and enforced a New York choice-of-law provision contained in the plan. The decision has important ramifications for employers that use incentive compensation plans to retain employees and wish to select a particular state’s law to govern the enforceability of those plans.

Drennen worked for Exxon in Houston for over thirty years. During his employment with Exxon, he participated in several incentive compensation plans, which included awards of stock options. In exchange for the options, Drennen signed a restricted-stock agreement that adopted the terms of Exxon’s incentive compensation plans. These plans included a choice-of-law provision specifying New York law. Further, the plans permitted Exxon to terminate any unvested options if the employee engaged in “detrimental activity,” which at least one plan explicitly defined to include “becom[ing] employed . . . by an entity that regulates, deals with, or competes with the Corporation or an affiliate.” After Drennen resigned his employment with Exxon and went to work for a competitor, Exxon notified Drennen that his 57,200 unvested shares were forfeited and cancelled by the plan administrator.

Drennen filed suit and sought a declaratory judgment that: (1) the detrimental activity provisions were tantamount to a covenant not to compete; (2) the covenants not to compete were unenforceable under Texas law because they were not limited in time, geographic area, or scope of activity restrained; and (3) Exxon’s cancellation of his unvested shares was an impermissible attempt to recover monetary damages on an unenforceable covenant not to compete. A jury found in favor of Exxon, but the court of appeals reversed. The appeals court held that the forfeiture provisions were unenforceable covenants not to compete and, notwithstanding the New York choice-of-law clause, Texas law prohibited the enforcement of the provisions as a matter of fundamental public policy.

The Texas Supreme Court reversed. The Court held that the application of the New York choice-of-law provision was permissible because, although Texas had the most significant relationship to the dispute and a materially greater interest in its determination, the application of New York law did not contravene the fundamental public policy of Texas. The Court reasoned that, even under Texas law, the forfeiture provision is not a covenant not to compete. The Court explained that, “[t]here is a distinction between a covenant not to compete and a forfeiture provision in a non-contributory profit-sharing plan because such plans do not restrict the employee’s right to future employment; rather, these plans force the employee to choose between competing with the former employer without restraint from the former employer and accepting the benefits of the retirement plan to which the employee contributed nothing.” The Court did not decide whether the forfeiture clause would be enforceable under Texas law (a question the Court explicitly declined to address), but instead held that, even if the application of Texas law might result in a different result, it could not conclude that applying New York law here offended the fundamental policy of Texas. Because the New York choice-of-law provision was enforceable, and New York law permitted Exxon to terminate Drennen’s unvested stock options, the Court reversed and rendered judgment in favor of Exxon.

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